As countries seek to defend their tax bases and extract more revenues from value created within their borders, tax authorities and international companies are coming into conflict more often — and this is just as true for tax authorities of competing jurisdictions.
Against this geopolitical backdrop, cross-border tax disputes have risen to new heights and the swell shows no signs of abating anytime soon. Countries worldwide are implementing the sweeping recommendations developed through the Organisation for Economic Co-operation and Development (OECD)’s base erosion and profit shifting (BEPS) project. Advances in technology are giving tax authorities new tools to assess risk and enforce compliance. And tax authorities are learning to cooperate and collaborate with each other like never before.
Some of the most important trends reshaping the global tax disputes environment are:
As these trends converge, they are set to transform the nature of tax controversy entirely. While this could spell even more tax uncertainty and disputes in the coming years, developments in progress today could ultimately reduce the amount and burden of tax disputes on companies with international operations.
Below we take a closer look at each of these trends.
The countries taking part in the OECD’s BEPS project realized early on that the scale of international tax change could put significant pressure on existing processes for resolving tax disputes. That’s why enhancements to the mutual agreement procedure (MAP) were included in the OECD’s Action Plan on BEPS at Action 14.
But as we get further into the BEPS implementation phase, it’s unclear whether MAP alone will be able to keep pace with the number of disputes which are arising. Country-by-country reporting, automatic exchange of tax information, mandatory disclosure in the EU under the directive on cross-border tax arrangements (DAC6), and various other anti-avoidance programs already in place are creating and have the potential to create substantial disputes
Some practitioners have observed that some taxpayers, like those in the Netherlands, are generally reluctant to engage in MAPs due to the considerable length of time involved. These taxpayers tend to reserve MAPs for bigger issues, relying on faster methods to resolve disputes such as litigating them domestically, settling them or accepting relatively minor amounts of double tax.
Other countries, like France, may put more stock in the value of MAPs, according to some practitioners, but the French Tax Authorities don’t have the resources they need to handle their mounting inventories. Outside the MAP, there is a need to manage the rising number of BEPS-related domestic tax disputes arising and that will arise in EU countries due to inconsistencies in its implementation of the European Union’s Anti-Tax Avoidance Directives (ATAD).
However, the BEPS measures are already benefiting the MAP process in some ways. For example, the BEPS framework for MAP reporting developed by the OECD’s FTA requires consistency in how countries report on their MAP activities. These requirements put peer pressure on countries like Italy to invest in bringing their MAP programs up to par — especially so they can meet the agreed goal of completing MAPs within 24 months.
The BEPS project is also encouraging countries to better align their tax systems with international norms. For example, Brazil, which has applied to join the OECD and taken an active role in the BEPS working groups, aims to simplify its tax system and make its cross-border tax regime more like those of the OECD member countries and other jurisdictions. At the end of 2018, Brazil announced a package of amendments that will open the MAP to more taxpayers.
The international consensus on the BEPS recommendations is also causing countries to dismantle barriers to the MAP process. Both Brazil and Italy have abolished rules preventing MAPs in cases where the relevant tax treaty does not require countries to make corresponding adjustments to their assessments to reflect MAP results. Domestic statute of limitation rules are also being changed to allow enough time for all the steps needed to resolve tax matters through MAPs.
Finally, about 200 tax officials have taken part in the OECD’s training for tax authorities that are new to the MAP. This common training is intended to help these tax authorities learn to negotiate with different cultures, and build the familiarity that can contribute to speedier dispute resolutions.
With some 10,000 tax disputes currently outstanding, strengthening the consistency and resourcing of MAP programs is not enough. The OECD’s Forum on Tax Administration (FTA) is working out a variety of ways to stop tax disputes from happening in the first place.
Formed in 2002, the FTA brings together 53 tax administrations around the world to share best practices, identify ways they can collaborate, and improve tax compliance. The FTA’s participants are commissioners at the most senior levels of their national tax authorities, and the group has come to influence the evolution of the world’s tax administrations.
Some initiatives that the FTA is working on to prevent tax disputes are as follows.
Mechanisms that force arbitration when parties cannot agree can be an effective way to end disputes. Arbitration of tax issues is also controversial, however, since not all countries are willing to accept the perceived loss of sovereignty that it can entail.
The OECD introduced arbitration in its model treaty in 2008. Today, about 250 tax treaties based on the model have arbitration clauses, and of these, 125 include mandatory binding arbitration. However, the treaties do not set any rules on how arbitration is to be conducted, so until this was agreed, the arbitration process was effectively out of reach.
With the multilateral instrument for amending tax treaties developing through the OECD’s BEPS project, 29 countries have opted to sign up for mandatory arbitration. While it’s unlikely that arbitration will be used extensively, the threat of it is now real, so countries will have more incentive to compromise and settle their tax disputes with other countries.
Arbitration of cross-border tax disputes has already been implemented by European Union member states. Unlike the bilateral arbitration mechanism included in tax treaties under the OECD model, arbitration in the EU is written into local law.
This increases legal protections for EU taxpayers, who previously had no recourse if a competent authority rejected their MAP application. Now, EU taxpayers can go to court and force the creation of an arbitration team if their dispute is not resolved within 2 years. This puts pressure on the competent authorities on both sides to find solutions more efficiently.
The world’s tax authorities are investing heavily in technology, with the goal of improving their ability to gather more tax information, check the quality of this data and gain insights into the tax and financial positions of taxpayers.
Brazil is an example of a country that is much farther along the road to tax system digitalization than most other countries. Brazil began digitalizing its tax system 10 years ago, starting with a central electronic invoicing system for indirect tax purposes in which tax authorities validate invoices before they are issued to buyers.
Now the country’s tax authorities have online access to detailed accounting data, including financial, manufacturing and payroll information. All tax returns are delivered in electronic format. About 98 percent of tax audits are conducted electronically in the background, and taxpayers often do not even know they are being audited.
The remaining 2 percent of audits result from flags raised through data and analytics, so tax auditors can go to the taxpayer with a better idea of what they want to assess. This allows for more targeted questions and documentation requests, and may lead to more accurate assessments.
Other tax authorities are working to catch up with this trend, encouraged by the OECD’s initiative to develop leading practices and guidance on how emerging technologies can help tax authorities improve how they manage taxes and enforce compliance.
Along with access to detailed transactional and financial data, advances in technology are also improving tax authorities’ processes for assessing tax risk. Their goal is to conduct fewer but better targeted and more effective tax audits.
In the UK, for example, the scope of HM Revenue & Customs (HMRC)’s risk assessment capabilities have expanded enormously in recent years. Previously, tax auditors had little more to go on than a taxpayer’s tax return and account information and what the taxpayer was willing to divulge.
New digital tax requirements combined with the Internet, social media and other technology-driven advances are arming HMRC auditors a wealth of information, such as:
Social media has proven a particularly rich source of information. For example, revenue authorities have been known to propose adjustments involving permanent establishments and other areas based in part on what they read in employees’ LinkedIn profiles.
This volume of information is potentially overwhelming. The HMRC has established a data analytics team, but human judgment is then brought to bear on whether to act on the information. In areas such as transfer pricing or the UK’s diverted profits tax, a taxpayer does not receive an information request from HMRC unless substantial groundwork has already been done, including vetting and approval by one of the HMRC’s governance boards.
As a result, transfer pricing and international tax audits in the UK have moved away from lengthy technical arguments to testing of the underlying facts. This puts more onus on the taxpayer to explain those facts and how their documentation aligns with what goes on in practice in the business. At the same time, audit queries are more efficient, because HMRC has already invested time to understand the business and the questions they ask are more targeted.
Companies can make their audits even more efficient by having their detailed narrative ready to provide context and support the business rationale behind the facts. That way, companies can respond quickly and completely to any tax audit queries they may be asked.
The volume of cross-border tax disputes is expected to continue to rise as we get deeper into the implementation phase of the OECD BEPS recommendations. The tax authorities are acutely aware of this, and of the stress this increased activity will put on both taxpayer and revenue authority resources alike. Tax authorities are attempting reduce both the volume and burden of tax controversy, for example, by implanting improved risk assessment procedures and offering new dispute prevention mechanisms.
Tax leaders can help reduce their potential tax disputes and speed up their resolution when they happen by: